Constant matirity swap November 27, 2009 at 4:51 pm
In a constant maturity swap, one party pays a fixed rate, or a short-term floating rate such as LIBOR, and the other party pays a floating rate that is the rate on a security known as a constant maturity treasury (CMT) security. The transaction is also sometimes known as a CMT swap. This underlying instrument is a hypothetical U.S. Treasury note, meaning that its maturity is in the 2- to 10-year range, with a constant maturity. Obviously the reference to a particular CMT cannot be referring to a single note, because the maturity of any security decreases continuously. As mentioned, the note is hypothetical. For example, for a two-year CMT security, when there is an actual two-year note, that note is the CMT security. Otherwise, the yield on a CMT security is interpolated from the yields of securities with surrounding maturities. The distinguishing characteristic of a constant maturity swap is that the maturity of the underlying security exceeds the length of the settlement period. For example, a CMT swap might call for payments every six months, with the rate based on the one-year CMT security. In contrast, a standard swap settling every six months would nearly always be based on a six-month security. Otherwise, however, a constant maturity swap possesses the general characteristics of a plain vanilla swap.